Question

Questions

1. What are the principal considerations in determining an overall credit policy? How do the actions of competitors affect a firm's credit policy?

3. 2. Why do exchange rates pose a challenge for financial managers of companies with international operations?

4. 3. What are the advantages and disadvantages of both debt and equity financing?

5. 4. Compare and contrast the three sources of short-term financing.

6. 5. Define venture capitalist, private equity fund, sovereign wealth fund, and hedge fund. Which of these four sources of funds invests the most money in start-up companies?

Answer 1

Answer to 1)

What are the considerations in determining the credit policy?

1. Terms of credit offered by the competitors are an important thing to be considered.
2. The company must try to compare the risks with the profits made. This is because company’s profits will decline due to bad debts provision.
3. The cost of offering the credit, credit terms and period of credit. All these are important factors to be considered.
4. Position of the economy in that particular country also influences the credit policy. Example of this is if the country is in boom or recession.
5. Nature of the business is also a factor. In heavy industries, credit period seems to be higher and vice versa.

Competitor’s actions:

This is one of the factors stated above. This is because if the competitors offer a good credit period compared to the individual company, then it may pose heavy pressure on the company to revise their credit policy. Also the business of the competitors seem to improve thereby they get more number of customers than us. Hence it is necessary for the company to monitor the competitors’ actions for its better performance and control over the market.

Answer to 2)

When a company is having overseas operations, it can face the following challenges:

1. The fluctuations in the exchange rates can either reduce the profits or increase the losses.
2. When a company enters into a new deal with the international firm, initially it may look good, but later it may stop the contract from getting enforced.
3. It would be difficult for the company to forecast its profit margin due to the fluctuations in the exchange rates.
4. The company is also responsible to its shareholders when its profits get reduced due to currency rate fluctuations.

Hence the company can avoid all these things by doing its business using the same currency. I.e. same currency for both buying and selling transactions.

Answer to 3)

Advantages of equity financing:

1. This involves less risk because you don’t have any fixed monthly payments and especially useful for start ups.
2. For financial growth of the organization, equity is the right choice because of their less interest rate.
3. The investors don’t expect immediate return on their investment and they are also ready to lose if the business fails.
4. Cash flow is good in case of equity, because they don’t take money out of the business.

Disadvantages:

1. There may be conflicts when making decisions in the company. Hence the owner must be ready to deal with difference of opinions.
2. Equity investors expect a high return on their investment. So the company has to share major part of their profits with them.
3. There may be loss of control. Because equity owners always want to play their role in decision making process.

Advantages of debt financing:

1. Under debt financing, the interest paid on loans provides tax benefit.
2. The company can adjust their cash flow because principal and interest payments are stated well in advance.
3. The owner can have control on his company. Because the debt holders don’t have rights in decision making process.

1. The owner of the business is required to offer collateral to his loan.
2. Too much of debts will create problems for the business which sometimes results in closure.
3. There may be difficulty in principal and interest payments when the cash flow of the company is not good.
4. There must be good credit rating for the company to get debt facility.

Answer to 4)

Three sources of short term financing:

• Bank loans:

Commercial banks offer loans of various kinds like line of credit, end of period payment loan. This is good because of the fixed amounts of principal and interest. If the business is not able to meet the requirement with a particular bank, they can go for one or more loans from syndicate of banks known as syndicated loans.

• Commercial paper:

This is a short term unsecured debt used by large companies and is considered to be cheaper than bank loans because the average maturity is 30 days and maximum maturity is 270 days. In US the minimum face value for a commercial paper is $ 25,000 and the commercial paper has a maximum face value of $ 1, 00,000.

• Secured financing:

Companies go in for secured financing by providing their receivables or inventory as security. The commercial banks can provide funds by discounting the invoices of its customers. In this case, the firm is assured of immediate payment for the sales made.

Answer to 5)

• Venture capitalist: a venture capitalist is someone who provides capital to the small business or to new businesses. The venture capitalists have a chance of earning more if the new ventures perform well. They are also at risk when they fund new start ups because they are not aware of their capacity and capability.
• Sovereign wealth fund: this is a pool of money that is derived from the country’s reserves and later used for investment purposes for the growth of country’s economy and also its citizens. The funds for this will come from exports made by the country and also from banks.
• Private equity fund: these come from investors who invest in private companies. This is not listed in a public exchange. The capital for private equity comes from retail and institutional investors which can be used for funding new technology.
• Hedge fund: these are considered as alternative investment options because they employ different strategies for getting active returns. These are accessible only to accredited investors because they require minimal SEC regulations. They are also prone to less regulation when compared to any other investment options.

It is only the venture capitalist from the above options who invest more money in the start up business because they are the ones exclusively available for new start up businesses.